Expected adjustments to the ECB’s asset purchase programme (APP) to address difficulties in finding public sector bonds are unlikely to affect covered bond purchases, according to analysts, with any expansion set to focus on PSPP. CBPP3 buying doubled last week on the back of increased market activity.

Ahead of a European Central Bank meeting tomorrow (Thursday), market participants have suggested that the ECB could in the coming months announce changes to its public sector purchase programme (PSPP) given a scarcity of government bonds from certain jurisdictions that are trading with sufficient yield to be eligible.

“Even though Eurozone government yields have risen since the UK referendum, the ECB has seen vast swathes of its ‘target bond universe’ disappear as rates have turned negative,” said Gary Kirk, partner, portfolio management, at TwentyFour Asset Management.

“The ECB has to venture out to seven year maturities in the German Bund market before they can find a bond at a yield wider than minus 40bp and they have to go out to five years in the French OAT or Dutch sectors.”

Market participants differed as to whether ECB president Mario Draghi will announce new measures after tomorrow’s meeting or after a meeting on 8 September, but agreed that some adjustments to the programme should be expected in the coming months.

They noted that the options open to the ECB include:

• The removal or lowering of the floor that currently restricts PSPP buying to bonds that have a yield above its deposit facility rate, which is currently minus 40bp;

• The removal of the capital key as a limiting factor for the asset purchase programme for any given sovereign;

• An increase of the issue share and issuer limits for bonds under the PSPP from the current 33%.

Some bankers said that the removal or relaxation of the deposit rate limit would be the easiest option for the ECB, noting that a deviation from the capital key split would be controversial.

“The main issue with scarcity at the moment affects the core government bond sector,” said Benjamin Schröder, senior rates strategist at ING. “You have around 55% of PSPP-eligible Bunds, up to maturities of seven years or so, trading below the deposit facility rate and thus out of reach for the Bundesbank.

“Removing the deposit rate floor would immediately open up the short end for purchases again.”

However, some analysts added that an adjustment of the deposit rate limit would also be difficult, as there would be consequences for the Bundesbank’s balance sheet of buying even more negative yielding debt.

Michael Spies, covered bond and SSA strategist at Citi, said his base case is that the ECB will in September raise its issue share and issuer limit for certain government bonds from 33% to at least 40%, even if only for bonds without collective action clauses (CACs).

“If they did this only for non-CAC bonds, they could continue to buy under the normal capital key for several months,” he said. “The Bundesbank would not face immediate scarcity for the next weeks.”

Analysts said that, whichever option the ECB chooses, the impact on purchases under CBPP3 will likely be limited.

“Any change to the overall APP will be done via PSPP,” said Spies. “When it comes to covered bonds I am not convinced that the ECB will increase their purchases.

“I think rather think we will continue to see a continuation of the stable purchases. We will see the scarcity dilemma for covered bonds as well during the summer, given the lack of primary and trading, but I don’t think there will be any substantial changes to the purchase procedure.”

ING’s Schröder agreed.

“The limits to the volumes that can be raised by the covered bond programme are well known, and gradually declining weekly volumes and shares in the overall purchases already reflect that,” he said. “Stepping up purchases in CBPP3 to counter issues in the PSPP is not an option, I think.”

Some analysts suggested that the ECB could also move back the earliest end-date of the APP from March 2017, or increase the overall target of the APP.

While expecting no major announcements from the ECB tomorrow, economists at ABN Amro suggested that the ECB will also in September increase its overall monthly APP target from Eu80bn to Eu100bn, while also extending the programme to at least the end of 2017.

Joost Beaumont, senior fixed income strategist at ABN Amro, noted that only a few covered bonds are currently yielding less than the ECB’s deposit rate.

“So in theory this should not be any barrier for the Eurosystem at the moment,” he said. “I stick to my view that the central bank will not materially alter its CBPP3 approach, buying around Eu6bn-Eu8bn per month – with a higher number depending on primary issuance.”

ECB figures released on Monday afternoon show that settled and outstanding purchases under the third covered bond purchase programme increased Eu1.407bn, from Eu184.100bn to Eu185.507bn, in the week to last Friday. Figures released yesterday (Tuesday) afternoon show that no CBPP3 holdings matured last week.

Analysts noted that purchases were therefore almost double those of the previous reporting period, when the CBPP3 portfolio grew by a net Eu530m, although gross buying was Eu730m, given Eu200m of redemptions.

“As such, it seems that the central bank is not yet facing any difficulties in finding covered bonds that it wants to buy – in contrast to what last week’s figures were suggesting,” said Beaumont. “This is probably related to the taps that we saw last week, which might have increased activity in the secondary market.”

Eu1bn of CBPP3-eligible issuance settled last week, of which analysts estimated the ECB bought around Eu240m. This implies the ECB bought an average of around Eu235m of covered bonds per day on the secondary market last week, compared to an average of Eu146m in the previous week.

Analysts noted that the pace of buying across the Eurosystem’s other purchase programmes also picked up last week. The public sector purchase programme (PSPP) portfolio was up Eu16.309bn, compared with Eu16.100bn in the previous reporting period, while the corporate sector purchase programme (CSPP) portfolio grew Eu1.953bn, up from Eu1.676bn.